Verano's Puzzling Summer Valuation

Mindset Value Fund Second Quarter 2021 Results

Disclaimer: The below post is my 2021 Second Quarter Letter that I sent to investors in the Mindset Value Fund. This post is NOT a solicitation. I talk about stocks that I own and my view of the future. It is imperative that you do your own due diligence and not rely on anything written below. I’m posting this in order to show how my writing translates to actual performance. With that, I hope you enjoy and gain insights.

Mindset Value Fund Second Quarter 2021 Results

I’m pleased to report that the Mindset Value Fund was up 14.1% net of fees for the second quarter of 2021 and is up 34.5% net of fees for the year.

A Value Investor’s Paradise

We’ve had a good start to the year, but it is the future I’m most excited about. Our portfolio is filled with companies which trade at a low valuation and yet have plenty of upside.

Not many technology companies with over 15 years of value creation trade at book value, but Nelnet (NYSE: NNI) does. And even that doesn’t describe how cheap the company is because my net asset value is approaching $125 per share, 71% higher than the recent stock price. A prime beneficiary from lower interest rates, Nelnet is not only printing cash from its loan servicing book, but also its student loan portfolio is in run off generating huge amounts of available cash. Nelnet is plowing that cash into growing its technology businesses and now renewable energy investments. And wait until the market gets an update on the value of Nelnet’s stake in the exciting youth sports technology startup, HUDL.

HireQuest (NASDAQ: HQI) currently has earnings power of $1.30 per share or more with a remarkable franchise business, one of the best CEOs I’ve come across and a business model with more than 50% operating margins. Yet remarkably, the stock still trades at 14.6 times this earnings power. And HireQuest has enormous runway for growth it has yet to tap into.

Mexican homebuilder, Consorcio Ara sells for 35% of book value, unlevered, and is about to reintroduce a 5% dividend. The resiliency of the management and business were on full display last year when despite an 8% contraction in GDP, ARA still generated a 15% free cash flow yield. And this ahead of a massive bull market in housing due to Mexico underbuilding the housing it needs.

And as I wrote in our last update, Bolsa Mexicana (Mexico: BOLSAA), itself is public and trades at an 8-9% trailing free cash flow yield, is growing at double digits, has no debt, pays a 5% dividend and also has a buyback ongoing for 5% of its shares. I wrote about how I think Mexico will benefit from tensions between China and the US:

In France, we own one of the most resilient and best businesses I have ever invested in. La Francaise des Jeux (France: FDJ) is the French national lottery and sports gambling monopoly. Remarkably, COVID is making the company structurally more profitable as more people are now playing the lottery online, which has more than double the margins as retail. Any uptick in COVID while of course unfortunate, only drives more gamblers to bet online.

And finally, we have 36% of the portfolio invested in five U.S. based cannabis stocks. All of these companies have minimal leverage, are growing like a weed and sell for single digit cash flow multiples. And as the time horizon lengthens to 2023 and beyond, the valuations get really silly with some trading at 5 to 6 times unlevered cash flow estimates. The companies we own are AYR Wellness (OTC: AYRWF), Cresco Labs (OTC: CRLBF), Glass House Brands (OTC: GLASF), an unnamed stock (will write about in the future) and one we want to dive deeper into in this letter, Verano Holdings (OTC: VRNOF).

Verano: The Best Run U.S. Cannabis Company Sells for the Lowest Multiple?

Institutional investor holdings in cannabis are tiny due to federal illegality, regulatory issues and many prime brokers that don’t allow custody of cannabis stocks. Jefferies & Company estimates that there is only 4% institutional involvement in the cannabis sector. This compares to 45% in other global staple sectors. Then consider that there is no real index involvement, either from the Russell or the S&P 500.

What is left is a few family run offices, a few hedge funds, dedicated cannabis investment funds and most importantly retail. So, what does this mean? There is a crazy amount of inefficiency in the market because 96% of institutional investors are not involved, not working on the sector, and leaving wide open opportunities.

So, let’s say you wanted to screen for the best US cannabis company. You might screen for margins, sales growth, cash flow generation, free cash flow conversion. You might also do a qualitative search for geographic scale and make sure the company was in the best states to do business. Well, if you were do this, there is one company that is a clear leader: Verano Holdings.

You would then expect that the company would then possess either the highest valuation or trade at a premium to other similar sized cannabis stocks. And that’s when you would be dead wrong. Ok, you might think maybe it could trade to a small discount to others if the market was as inefficient as I have described. Maybe at most 15% or 20%. Again, you would be wrong.

Would you believe that one of the best companies in an industry would trade at a 50% discount to two other similar sized companies and at the bottom end for any company even close to its size?

How in the world is this possible? Here are some of the reasons I have been able to ascertain and none of them have to do with fundamentals. First, is that Verano is a recent IPO (February) that is not known well by the few existing investors that traffic in the cannabis space. Another reason is that if capital is constrained and institutions are limited, then those institutions would have to sell existing names to buy Verano.

Another more powerful reason is that in a world that is dominated by retail, which follows social media and name recognition, Verano has committed the cardinal sin of not having a social media presence and conducting lots of public interviews. Green Thumb (OTC: GTBIF) and Curaleaf (OTC: CURLF), trade at 15 to 16 times cash flow on 2022 estimates yet underperform Verano on margins, cash flow generation and cash conversion to free cash, but they have something Verano doesn’t have. Both CEOs are active on Twitter and social media and do tons of interviews.

Another factor is that there is only one main ETF in the space, MSOS, and its movements in a sector that has limited investment capacity really distorts things. The ETF has over $900 million in assets and while Green Thumb and Curaleaf represent 13% and 12% of the ETF, what percentage does Verano have? Inexplicably, MSOS has only 2.92% of its ETF invested in Verano. It has 3.4% of its assets in Jushi Holdings (OTC: JUSHF) a company estimated to produce just $38 million in EBITDA this year, while Verano is on target to produce ten times that amount. If MSOS held the same amount of Verano that it held of Green Thumb, the ETF would have to buy an additional 7 million shares.

But the most important reason for the discount in valuation is that on August 10th, 50% of the shares that have been locked up post-IPO become unlocked to be freely traded. And in the capital constrained cannabis world, this looks scary. But therein lies the opportunity. Look a little in the future and does it make sense for Verano to trade at a discount?

Only in the upside/down world of cannabis could possibly the best run U.S. cannabis company sell for half the multiple of its peers. The best part of the investment in Verano is that I don’t even need new legislation or any changes on the Federal level. I just need the cannabis space to become a little more efficient and the stock will explode higher.

Verano is estimated to produce over $370 million in cash flow this year, close to $600 million in 2022 and new estimates now have the company approaching $700 million in 2023. Continue that trend on into 2025 and you have $1 billion in cash flow, slap a multiple commensurate with alcohol or other global staple companies and Verano has the potential to go up FIVE times in price.

There are so many opportunities in cannabis, it makes my head spin, but Verano is a special one because it aligns with the guiding investment philosophy for the fund.

The Mindset Value Way: Low Downside, Uncertain Upside

The Fund’s investment strategy is to research and invest in undervalued, misunderstood, or unfollowed publicly traded securities that offer limited downside over the long term, but also have an uncertain upside. The portfolio will consist of investments that offer a “heads I win, tails I don’t lose” strategic approach to investing. To use baseball as an analogy, we are focusing on hitting singles and doubles, but just might have a shot at hitting a homerun, but whatever we do, we don’t want to strikeout.

Summary

The stock market from the bottom last March has been almost straight up. It would not surprise me to encounter downdrafts, volatility and more. While I have no idea how our stocks or the stock market in general is going to act in the short run, I’m very excited about the long-term prospects of our portfolio. As always, if you have any questions or comments, feel free to reach out to me anytime.

Sincerely,

Aaron M. Edelheit